Overview and Interpretation

Question 1

What is the formula for Return on Equity?

Answer 1

(Profit for the year - preference dividend) / (Ordinary share capital + reserves) x 100%

• May be able to use the average figure for shareholders funds= (funds at start of year + funds at end of year)/2
• Comparing profit for the year with a figure that is at a point in time
• Needs 3 years of data
• This ratio measures the profitability of a firm in relation to shareholders’ equity.

This ratio measures the profitability of a firm in relation to shareholders’ equity.

Question 2

How is Asset Turnover (Total Assets) calculated?

Answer 2

This ratio indicates how effectively a company is using its total assets to generate sales.

Question 3

Ratio relationships (3)

Answer 3

ROCE = PBIT/Capital Employed

= Profit margin x Asset turnover

ROCE is influenced by

Pyramid approach – can drill down further

Question 4

How is Return on Capital Employed calculated?

Answer 4

This ratio assesses a company’s efficiency at using its capital.

Question 5

What is the formula for Net / Operating Profit Margin?

Answer 5

This ratio indicates how much profit a company makes for every pound of revenue.

Question 6

How is Gross Profit Margin calculated?

Answer 6

This ratio shows the percentage of revenue that exceeds the cost of goods sold.

Question 7

What does the Expense/Revenue Percentage measure?

Answer 7

This ratio reflects the proportion of revenue that is consumed by specific expenses.

Question 8

Define Asset Turnover (Net Assets)

Answer 8

This ratio evaluates the efficiency of a company’s use of its assets to generate sales.

Question 9

What is the formula for Non-Current Asset Turnover?

Answer 9

This ratio measures how efficiently a company uses its non-current assets to generate revenue.

Question 10

What does Return on Total Assets measure?

Answer 10

This ratio assesses a company’s ability to generate profit from its assets.

Question 11

What is the Current Ratio?

Answer 11

This ratio indicates a company’s ability to cover its short-term obligations with its short-term assets.

It can be dangerous if less than 1 but it depends on industry

This ratio indicates a company’s ability to cover its short-term obligations with its short-term assets.

Question 12

Define the Quick Ratio or Acid Test Ratio.

Answer 12

This ratio measures a company’s ability to meet its short-term liabilities without relying on the sale of inventory.

Question 13

How is Average Inventory Turnover Period/ inventory days calculated?

Answer 13

This metric indicates how long inventory is held before it is sold.
Average inventory = (opening inventory + closing inventory)/2

Question 14

What is the formula for Average Inventory Turnover?

Answer 14

This ratio shows how many times a company’s inventory is sold and replaced over a period.
Average inventory = (opening inventory + closing inventory)/2

This ratio shows how many times a company’s inventory is sold and replaced over a period.

Question 15

How do you calculate Trade Receivables Days?

Answer 15

This metric indicates the average number of days it takes a company to collect payment after a sale.

Question 16

What is the formula for Trade Payables Days?

Answer 16

This metric shows the average number of days a company takes to pay its suppliers.

Question 17

Define the Working Capital Cycle (days).

Answer 17

This cycle measures the time taken to convert current assets and liabilities into cash.

Question 18

What is Gearing?

Answer 18

This ratio measures the proportion of a company’s capital that comes from debt.

Question 19

How is Debt/Equity calculated?

Answer 19

This ratio compares a company’s total liabilities to its shareholders’ equity.

Question 20

What is the Interest Cover ratio?

Answer 20

This ratio indicates how easily a company can pay interest on outstanding debt.

Question 21

How is Dividend Cover calculated?

Answer 21

This ratio shows how many times a company can pay dividends to its shareholders from its net profit.

Question 22

What is the formula for Dividend Yield?

Answer 22

This ratio measures the return on investment for a stock based on its dividend payments.

Question 23

How is Earnings per Share calculated?

Answer 23

This metric indicates the portion of a company’s profit allocated to each outstanding share of common stock.

• Used to estimate future growth which affects future share price.
• Measure of growth over time – may be manipulated
• Not all the profit has to be paid out in the form of dividends
• Allows comparison between one year’s earnings and the next because profit is related to the tangible number of shares in issue
• Share issue during the year

This metric indicates the portion of a company’s profit allocated to each outstanding share of common stock.

Question 24

What does the Price/Earnings ratio indicate?

Answer 24

This ratio helps assess the relative value of a company’s shares.

Question 25

The interpretation process (5)

Answer 25

* Objectives of the analysis and the intended recipient e.g. Investor, management, board of directors * General overview, wider considerations * Industry norms – may be hard to find * Horizontal analysis – over time, >2yrs * Vertical analysis, common sized statements - May aid intercompany comparisons

Question 26

Exam approach (4) How to get started (2+3)

Answer 26

* What format are you required to use? Be professional! * Be mindful of the audience – internal manager, executive director, non-executive director, investor? * Question – address the requirements given * Brief conclusion – no new information _How to get started_ * Either calculate the ratios required of you or decide on the most appropriate and calculate them * Work your way down the statements addressing each requirement in turn: 1. State your calculated ratios 2. How do they differ? 3. So what? Can you link information?

Question 27

Limitations of ratio analysis (4)

Answer 27

* Lack of standard definitions – not governed by IFRS (except for EPS) * Are two companies truly comparable? - Accounting policy choices * Timing – SOFP shows one point in time

Question 28

**The purpose of interpretation** What is the objective of financial statements? Who are the users of financial statements? What are the fundamental and enhancing qualitative characteristics?

Answer 28

What is the objective of financial statements? - To provide users with information to help them make decisions about providing resources to an entity Who are the users of financial statements? - Investors (current/ prospective), creditors, employees, HMRC etc Fundamental qualitative characteristics: - Relevance and faithful representation Enhancing qualitative characteristics: - Verifiability, Comparability, Understandability, Timeliness | RFVCUT

Question 29

**The potential of ratio analysis as an analytical / interpretive tool** What is the problem with numbers? How do we increase the value and what effect does this have? Allow comparison across: (4)

Answer 29

The problem with numbers: - Isolated numbers have little or no value We add value through division into other, contextualising numbers - Assesses the financial health / financial position and performance through structured analysis Allow comparison across: - Time - Divisions/subsidiaries of the same organisation - Different organisations, may be different sizes - Planned performance Prediction analysis

Question 30

Overview of techniques for analysis Who helps to achieve uniformity in the preparation of financial statements? Check...? Be aware of ______________ __________ No _______ or ________ answer

Answer 30

* IFRS help to achieve uniformity in the preparation of financial statements * Check the accounting policies between companies / over time * Be aware of underlying issues * No right or wrong answer

Question 31

Example question Ali and Bhaskar Return on shareholders’ funds? Return on capital employed? Operating profit margin? Gross profit margin?

Answer 31

Question 32

What year can average inventories be calculated for?

Answer 32

Average inventories can only be calculated for 2023. i.e. (£5,169.6m + £5,169.6m) / 2 Would need the 2021 figure to calculate average inventories for 2022 Average inventories can only be calculated for 2023. i.e. (£5,169.6m + £5,169.6m) / 2 Would need the 2021 figure to calculate average inventories for 2022

Question 33

What year can average inventories be calculated for?

Answer 33

Can calculate average inventories for ye 2024 and 2023 2024 = (£2,635m + £2,510m) / 2 = £2,572.5m 2023 = (£2,510m + £2,339m) / 2 = £2,424.5m

Question 34

Financial Gearing: Example Fill out debt/equity

Answer 34

Question 35

Taxation is 30% of profit before tax, but after interest Which company would you consider to be more highly geared? What is the profit available to shareholders if operating profit = £50,000?

Answer 35

Question 36

What is the return on ordinary shareholders funds?

Answer 36

Question 37

What happens if operating profits increase or decrease by 20%

Answer 37